The Official Blog Of Larry Berman - CFA, CMT, CTA

What is the Best Long-Term Indicator of Market Returns and What is it Saying Now?

According to Mark Hulbert of Financial Digest fame, a sentiment based independent based analyst firm, the single best (long-term 10 years) predictor of future returns is equity share of household assets. These data can be followed (annually) on the Federal Reserve Board of St. Louis (FRED) economic indicators data base. The chart today is courtesy of Ned Davis Research, one of the top independent market research firms in the world.

The forward 10 year return based on how much equity households own in the stock market. We are currently in the top 20% historically (since 1951) and that suggests returns over the next decade will be significantly lower than average.

When the statistics are run on several longer-term forecasting methods, the highest correlation to the forward 10-year return is seen by this indicator. The rational is when everyone owns equities, there are no more buyers left to buy. Other methods offer good longer-term predictions too. The overall size of the market compared to the economy is second best, and the long-term smoothed (cyclically adjusted) P/E ratio (Shiller) is also quite good. Just looking at the most recent 12-month trailing P/E is not better than a coin flip when looking down the road at returns.

LONGER-TERM FORECASTING

CORRELATION

HOUSEHOLD EQUITY
ALLOCATION

MARKET CAP TO GDP

SHILLER CAPE RATIO

P/E TRAILING
12 MTHS

R-Squared

0.91

0.76

0.66

0.50

This does not mean you run out and sell everything, but it tells you that for the next decade, buy and hold returns are not likely going to give you the experience you are hoping for. And while I advocate for using passive ETFs to build portfolios, I complement the passive indexing approach with active tactical asset allocation to reduce risks and enhance returns.

About the authorLarry Berman

Larry Berman is a Co-Founder of ETF Capital Management and the Prosper Experiential Media. Over his 25 year career, Larry has worked for numerous top firms in New York, Boston, and Toronto. Prior to founding ETFCM (2006), he was Chief Technical Strategist and Managing Director for CIBC World Markets for nearly a decade where he was ranked as one of Canada’s “Top 3 Analysts” according to Brendan Wood institutional investor surveys. READ MORE